Bank of Hawaii Corporation (BOH) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Bank of Hawaii Corporation First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will host a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded for reply purposes. Now, I'd like to hand the call over to Cindy Wyrick, Investor of Investor Relations. Ma'am, you have the floor.

Thank you, Brian. Good morning and good afternoon, everyone. Thank you for joining us today as we discuss the financial results for our first quarter 2016. Joining me today is our Chairman, President and CEO, Peter Ho; our Vice Chairman and Chief Financial Officer, Kent Lucien; and our Vice Chairman and Chief Risk Officer, Mary Sellers. The comments today will refer to the financial information that was included in our earnings announcement this morning. Before we get started, let me remind you that today's conference call will contain some forward-looking statements and while we believe our assumptions are reasonable, there are a variety of reasons that the actual results may differ materially from those projected. And now I'd like to turn the call over to Peter Ho.

Thanks, Cindy. Good morning and aloha everyone. Thanks for joining us. Bank of Hawaii began 2016 with a strong first quarter. Fully diluted earnings per share were $1.16. Loan balances grew to $8.1 billion at quarter end. Average loan growth in the quarter was 2% sequentially and 12.6% on a year-over-year basis. Deposit balances grew to $13.5 billion at quarter end. Average deposit growth from the quarter was 2.3% sequentially and 4.3% year-over-year. Average core deposit growth was 2.2% sequentially and 6.3% year-over-year. During the quarter we sold 100,000 Class B Visa shares. We also received a large recovery on loans previously charged off with single commercial client. Asset quality remains strong, NPAs to total loans, leases and foreclosed real estate was 27 basis points as compared to 40 basis points a year ago. The ratio of annualized net charge-offs to average loans and leases was minus 19 basis points versus positive 7 basis points a year ago. And now let me turn the phone over to Kent, who will provide you with further detail on our financial performance for the quarter. Mary will also provide further color on our asset quality profile. Kent?

Thank you, Peter. Net income for the first quarter was $50.2 million or $1.16 per share compared to $42.8 million or $0.99 per share in the fourth quarter and $42.4 million or $0.97 per share in the first quarter last year. Our return on assets in the first quarter was 1.30%, return on equity was 17.88% and our efficiency ratio was 54.88%. Our net interest margin in the first quarter was 2.86%, up 1 basis point from the fourth quarter and up 5 basis points from the same quarter last year. Net interest income in the first quarter of 2016 included interest recoveries of $1.3 million which had a positive impact of approximately 4 basis points on the net interest margin. Premium amortization was $11.7 million in the first quarter, up slightly from $11.6 million in the previous quarter. Investment portfolio reinvestment differential was a negative 43 basis points this quarter. During the first quarter, we purchased 218 million in securities including a high proportion of floating rate securities. As Mary will discuss later, we recorded a negative credit provision of $2 million this quarter. Non-interest income in the first quarter of 2016 included a net gain of $11.2 million from the sale of 100,000 Visa Class B shares and a $1.9 million net gain on the sale of equipment leases. Non-interest income in the fourth quarter of 2015 included a gain of $1 million due to a distribution from a low income housing partnership. Non-interest income in the first quarter of 2015 included a net gain of $10.1 million from the sale of 95,000 Visa Class B shares. We do not anticipate further sales of Visa shares in 2016. Non-interest expense totaled $87.4 million in the first quarter of 2016 compared with $85.7 million in the fourth quarter and $86.9 million in the first quarter of 2015. Results for the first quarter of 2016 included seasonal payroll related expenses of approximately $2.5 million, an increase of $500,000 to the provision for unfunded commitments and severance payments of $300,000. Expenses during the first quarter were partially offset by a net gain of $1.5 million from the sale of our real estate property in Guam. Results for the fourth quarter of 2015 included net gains of $3.9 million related to the disposal of two branches partially offset by $1.3 million for the roll-out of chip-enabled debit cards, operating losses of $1.1 million, and severance payments of $500,000. Noninterest expense in the first quarter of last year also included seasonal payroll-related expenses of approximately $2.5 million and $1.9 million in severance payments. Adjusted for all these items, non-interest expense in the first quarter of 2016 was down 1.3% from the previous quarter and up 3.8% compared to the same quarter last year. The increase from the previous year was primarily due to higher salaries and benefits expenses, resulting from continued strong loan production and higher overall operating income. In addition, expenses were impacted due to increased investments and solar tax credit partnerships, which resulted in tax benefits that reduced our income tax expense. The effective income tax rate for the first quarter of 2016 was 32.01% compared with 28.23% in the previous quarter and 31.72% in the same quarter last year. The lower effective tax rate during the fourth quarter was related to the sale of a low-income housing investment. As Peter mentioned, we continue to see good growth in our loan portfolio during the first quarter. Our investment portfolio decreased slightly to $6.2 billion. And the average duration of the AFS portfolio was 2.2 years, and the overall portfolio duration was 2.9 years at the end of the quarter. Deposit growth also remained strong. Consumer deposits increased 1.9% from the previous quarter and up 5.6% compared to last year. Commercial deposits also increased up 3.2% from the previous quarter and up 4.3% compared to last year. Our shareholders' equity increased to $1.14 billion at the end of the first quarter. We paid out $19.5 million or 38% of net income in dividends during the quarter, and repurchased 297,000 shares of common stock for $18.7 million. Our Board authorized an increase of $100 million in our share repurchase program resulting in a remaining authority of $104.3 million as of the end of the first quarter. At the end of the first quarter, our Tier 1 capital ratio was 13.85% and our Tier 1 leverage ratio was 7.25%. And finally, our Board declared an increased dividend to $0.48 per share for the second quarter of 2016. Now, I'll turn the call over to Mary.

Thanks Kent. For the first quarter of 2016, we recorded a net recovery of loans and leases previously charged off of $3.8 million, compared with net charge-offs of $2.2 million in the fourth quarter of 2015 and $1.2 million in the first quarter of 2015. The recovery position was primarily due to the full recovery of a commercial loans where single client, which was charged-off in 2013. Non-performing assets were $22 million at the end of the quarter, down $6.8 million for both the linked period and year-over-year with the decreases largely related to the reference commercial client. At the end of the quarter, loans passed through 90 days or more and still accruing interest totaled $7.9 million, up $364,000 for the linked period and flat year-over-year. Restructured loans, not included in non-accrual loans or loans passed through 90 days or more were $50.7 million, up $1.3 million for the linked period and up $4.1 million year-over-year. Residential mortgage and home equity loans modified to assist our customers accounted for $23 million of the total. The allowance for loan and lease losses was $104.7 million at the end of the first quarter, an increase of $1.8 million from the fourth quarter of 2015 and a decrease of $2.8 million from the first quarter of 2015. Given the recoveries of $3.8 million, a negative provision for credit losses up $2 million was recorded. The ratio of the allowance of loan and lease losses to total loans and leases outstanding was $1.3 million at the end of the quarter compared with $1.31 million at the end of the 2015 and $1.5 million at the end of the first quarter of 2015. The reserve for unfunded commitments was $6.6 million, up $500,000 for the linked period and $685, 000 year-over-year. I will now turn the call back to Peter.

Thanks Mary. The Hawaiian market continues to perform well. The visitor industry continued its trend of steady growth with February year-to-date visitor spending growth of 3.8% and visitor day growth of 3% from a year ago. Airlifted of the Hawaiian market was 7.5 higher in February. Construction activity remains strong and well diversified amongst both the public and private sector. Residential real estate market remains consistent as prices continue to reach new levels on Oahu, our primary market. VN home prices grew 7.2% in the quarter from a year ago or condominium prices rose 4.5% from a year ago. Inventory continues to tighten with much inventory levels at 2.1 months for single- family homes and 2.3 months for condominiums as compared to 2.7 months or 3.4 months respectable a year ago. The seasonally-adjusted state-wide unemployment rate was 3.1% at March as compared to 5% nationally. Thanks again for joining us today. And now we will be happy to respond to whatever questions you might have.

[Operator Instructions] Our first question comes from Joe Morford with RBC Capital Markets. Your line is now open. Please go ahead.

Thanks, good morning, everyone. I guess first on the margin, I was curious if the December rate hike had much of an impact at all this quarter. And given the drop in reinvestment rates, what are you currently thinking in terms of the outlook for the margin from here?

So I think we have been able to maintain a fairly even keel on a margin, so year-over-year we're just about flat. So the remixing of the balance sheet is really serving to offset the negative differential in the securities portfolio. So, barring any change in market conditions that's probably the outlook for us.

So pretty stable outlook from here?

I think though - we're seeing a little bit of improvement in the market and over the last week or so but that's a pretty small change.

Right; okay. And then you saw solid uptick in commercial C&I balances this quarter after some softness in the fourth quarter. Just curious; what drove the increase there? Perhaps was it some little better line utilization rates at all?

Yes Joe, you hit it there and - so C&I growth on a end of period basis as you eliminated was pretty strong. On an average basis though, it wasn't quite a strong. So average C&I loans on a linked basis were down, little over 2% and down 0.3% on a year-over-year basis. Basically what happened was we had some very strong funding at quarter end which boosted the end of period balances. But longer terms as we look forward, I think as we've discussed in the past, C&I is probably the one loan category that we feel could began to flatten out a bit for us not because of any markets presence we have here in Hawaii, but really as a result of where we are in front of cycle right now number one. And number two, the fact that as we get deeper in the credit cycle, a lot of production on the commercial side is going and coming on a secured basis.

Right. Okay; thanks so much.

Thank you. Our next questions come from Ken Zerbe with Morgan Stanley. Your line is now open. Please go ahead.

Okay, thank you. I guess just sticking with the NIM question, looking at your securities portfolio, like, a lot of other banks had - saw pretty noticeable increases in security yields or in the NIM overall just given the rate hike. I know you guys have such a large securities portfolio, why - is there something in there that prevented us from seeing a bigger increase in your security yields or overall NIM versus some of your peers? Because I would've thought you guys would have seen more of a step up in margin.

I really can't comment on what the peers are doing but you know we have been tending to reinvest into the floating rates area as compared to any longer duration, fixed rate security. So that's going to have an impact on the yield within that separate line item. On the other hand, our loans in the fixed rate area including residential mortgages and home equity, now there is a tendency for more longer duration, a little bit higher yielding results in that category. So it's really the total that you got to take into account.

Okay. And then with Visa I know you said no more sales this year. Should we expect another, I don't know, $10 million in first quarter of next year of sales?

That would probably be the right way to look at it.

Got you. Okay, all right. Thank you very much.

Thank you. Our next comes from the line of Ebrahim Poonawala with Merrill Lynch. Your line is now open. Please go ahead.

Good morning, guys. I guess related to margin, but if you could just touch upon - if you can talk about deposits and what we've seen, if any, real impact from a competitive behavior in deposit pricing off of the Fed rate hike. And what are your expectations around deposit growth as the year progresses?

So our deposits are obviously consumer business and institutional governmental, right. And really so, let me focus on a consumer business because I think that’s probably most prudent to your question. Consumer deposit growth - core deposit growth for us has been quite strong. So we are up average year-over-year core deposits, consumer up 6%. Within embedded in that number is a demand deposit, increase of 8.8% on the consumer side average year-over-year. On the business side, core deposits are up on average 5.8% year-over-year and embedded in that core number are demand deposits for a business customer, 7.5%. So we’re seeing very strong deposit flow tending on the lower price segment of the product categories. We haven’t seen a lot of - I haven't seen much in the way of price action in the time area, it's just not been an area that we focus on for obvious reasons.

Got it. Thanks for that. The other question, just shifting to credit, Peter, you alluded to where we are in the credit cycle. I'm just trying to get a sense of if it feels like the economy is doing very well right now just across the board. If we do actually begin to see a slowdown, what would be the areas where you would first look at to see any signs of cracks emerging?

Well, I think that generally, commercial tends to lead into a cycle and lead down in the cycle. We would anticipate that to be the situation again if and when we get to that point in the cycle. By the way, we don't think we’re at, at this point. So within commercial, it’s kind of the general hierarchy. So C&I are unsecured loans, are probably when it's slow down or have some challenges first, commercial real estate would be second, if at all. And constructions somewhere – well the construction is generally a short term or intended to be a short term maturity type of deal. So that's what we would anticipate to see. And to be honest with you, that's what we are building a bit into our underwriting as we move forward.

Got it. That's helpful. Thank you very much for taking my questions.

[Operator Instructions] Our next question comes from Jacque Chimera with KBW. Your line is now open. Please go ahead.

Hi, good morning, everyone. The construction fundings in the quarter, was that new business? Or was it maybe drawdowns on some loans that were previously booked?

Mostly drawdowns on loans that had been previously booked.

So as we look - and this shifts a little bit of my question, given answer that you just gave. But on the last quarter you talked about moving more towards a four-year average loan growth, and I would have expected 1Q's loan growth to be a little slower, just given seasonal pressures. Do you still feel that we're going to move towards the average loan growth? Or has anything changed over the past three months and given the strength in the first quarter that leads you to believe you could have a stronger year than that?

I think Jacque that, we've been thinking in terms of higher single digit loan growth. I know that’s not been the outcome for recent past. But as we think longer term into our models, that's what we see. And we see that as a result of - as we’ve discussed this morning, a maturing commercial cycle. Residential still looks strong. Consumer still looks very strong. We would anticipate those markets and those products to continue to do well. But we mix everything together. We still come out to kind of a higher single digit level.

Okay. So just a very strong quarter that you had in the first quarter, nothing really to read into it, into future quarters?

I think so.

Okay, all right. Then also if I look at the reserve build, this is the first quarter of net new build in about six years. Is it in inflection point that you're seeing, or is it just coincidental?

Jacque, each quarter we do take a look at the reserve and look at the risk profile at our portfolio, the growth in the various segments and really what’s happening in the environment. So, clearly - and then we look at net charge-off of recoveries to kindly get to the net efficient.

Okay, all right. That's all that I have right now. Thank you.

Thank you. Our next question comes from Jeff Rulis with D.A. Davidson. Your line is now open. Please go ahead.

Thanks; good morning. Question on - I guess the makeup of the comp expense. Just looking year-over-year, in Q1 you had a higher increase in incentive comp this year than you did last year. Is that a product of maybe a change in how you view retention, or was it really just production-driven on that end?

It was production driven. We are thinking through retention items which I think are going to have the effect, I think had the effect in the quarter or may have the effect moving forward of some higher comp numbers which we think is the right strategic move for us. There was may be a $0.5 million in – what I would consider to be a non-recurring comp that was paid out in that quarter that probably won’t flow through to future quarters. But in general to get to your question, yes, we probably will see somewhat elevated level of comp in that line or number of dollars in that line.

And, Peter, is that in response to anything competitively on the island that you feel you've got to step that up? Or is it competitive on the talent side? Anything in response?

It's really a two-fold. It is in fact a function of the competitive nature of our industry today. But it’s also bit retroactive in - we just had really strong performance for a while now, and we needed to reward number of our key players.

Makes sense. Okay, that was it for me. Thanks.

Thank you. Our next question comes from Aaron Deer with Sandler O'Neill Partners. Your line is now open. Please go ahead.

Good morning, guys. Peter, just following up on the last question with higher comp expectations, are there other areas that might offset some of that in terms of branch downsizing or consolidation or anything else?

Actually – Kent's really been the person heading up for branch consolidation, so if you don’t mind I will let him answer that.

Yes, Aaron. I think there are opportunities into the future in occupancy in particular. So we are underway with the number of projects. The effect of those projects will be to modernize our network. We may have approximately the same number of locations when we’re done but certainly the number of square feet that we occupy will be lower. And it could be up to the third lower than what we have today. And so that really is a major source of savings for us.

Okay, that's great. And then also, Kent, on the solar credits, anything that we should think about in terms of the tax rate differentiating from the effective rate of the first quarter, as we look out to the second, third, and fourth quarters?

You get a little bit higher effective rate and based upon the level of pretax income and so we had a higher level of pretax income in the first quarter, it was elevated from some of the one-time items that we've talked about. So it tends to blunt a little bit the impact with some of the credits. Its income - pretax income is little bit lower, the impact of the credits was that much higher in a proportionate sense. And therefore the effective rate could actually be a little bit lower.

It seems like it wouldn't be too much, though, right? I mean, we're like 31% instead of the 32%, somewhere around there. Is that reasonable?

Well, that's in the neighborhood of what we had in the first quarter of last year so, that yes, that’s one way of looking at it.

Okay. And then a quick one for Mary. The credit service have been terrific. Any expectation for additional recoveries that might be had, or is that pretty much played out at this point?

It's pretty much played out at this point. But we expect to see a modest stream still within our residential and home equity but nothing at the magnitude here.

Okay, terrific. Thanks for taking my questions.

Thank you. Our next question comes from the line of Casey Haire with Jeffries. Your line is now open. Please go ahead.

Hi, good morning, guys. Kent, wanted to follow-up, just clarify on the stable NIM outlook. By my calculation it's about a 4 bp helper from the recovery this quarter. Are you saying that we can hold flat at 286, or is it - or 282 and positive mix shift holds it there?

Well I was really referring to the after recovery at margin and I was comparing it to the same period last year. So we were at 281 last year and adjusted for the recovery 282. So, that’s kind of what I was talking about that abs and changes in market conditions and we always have changes in market conditions, and I think the effect of loan growth has been serving to offset the differential and the reinvestment yield. So like I said, if there is no change in conditions, I think we could see generally the same impact and always had a basis point here there but generally that's a result.

Okay, great; thanks for clearing that up. To the changing market conditions, I think I heard you say it was minus 43 bps differential in the first quarter. Where is that as we stand today?

It depends on whether I replicate exactly what I did in the first quarter. So we bought a lot of floating rate securities in first quarter. If I replicated that exactly into the future, if I see the same kind of differential. However, having said that, we probably will not replicate exactly what we did in the first quarter. So just to remix or reinvest exactly the same proportions that we have in the portfolio right now, you see it lower differential today than you would have seen in the first quarter.

Okay, great. So yes, just the investment strategy is getting a little bit - no more floating rate, which would be lower yield; so that helps you out there. Okay.

I would say no more, I am just saying the relative.

Yes, okay. And then have you - can you let us know what the premium amortization was in the quarter? If memory serves that's always been a bit of a lag for you guys. Is that a headwind, I would assume, going forward?

It was $11.7 million in the first quarter, in the fourth quarter was $11.6 million. So it’s actually been trending down over a longer period of time just because really the size of securities portfolio is getting smaller. So anyway.

Okay, yes, all right. Then just last one for me, just switching gears on the expense side. Looks like it was up year-over-year 2%. I believe on the fourth quarter call you guys outlined a number of initiatives on the - some investments in modernizing the infrastructure a little bit. That was going to track the expenses to around 3%; coming in a little bit light versus that. Is that still the expectation for 2016?

Yes, your memory is very good on that point. We've been referencing 3% as a indicator for the future and is really comprised of three elements, higher sales activity, general inflation, and the third category initiative. And each of the categories, roughly, not exactly, but roughly 1 percentage point so aggregating to three in total. And as we go forward, the opportunity is that the initiatives which we're really making investments now, but they're treated as expenses will turn and we'll see the fruits of those investments such that we have opportunity to get little bit lower than that 3%. But that's off into the future a little bit.

Okay, understood. Thanks for taking the questions.

Thank you. Our next question comes from the line of John Moran with Macquarie Capital. Your line is now open. Please go ahead.

Hi, how's it going? I just - the OpEx one was actually the question that I wanted to ask, but I'll ask you more broadly. Just the dollar strength, some slowdown in Asia and Canada, are you guys seeing any early impact in terms of visitation? Or are things cooling a little bit here?

Well, so really what we've been hit with is a stronger dollar namely in Japan and Canada. Japan was impacted pretty significantly last year and is not as impacted as much this year. Now, in the first quarter, the yen actually strengthened a bit versus the dollar. So that's what's happening there. It's kind of flat visitor day. It's just slightly up from the Japanese market today. Spend down just under 5% year-to-date. Out in Canada, last year what we saw, so Canada has been impacted by the U.S. dollar as well I'm going to surmise, by what's happening with energy prices. They were down a bit, both in terms of spend and visitor days, last year, but very nominally. And what we've seen at least so far and it's earlier in the year, but a pretty substantial decline in both visitor days and spending here in Hawaii visitor market. Now, Canada represents about 13% of our total business here in the islands.

Okay; understood. Then anything out of the military side of things? Any update on what's going on there?

Seems pretty stable. I think no real news, one way or the other. I think post-sequestration, the Hawaiian market has fared pretty favorably. And in some part of it what we are benefiting from is the Pentagon-stated pivot into the Pacific because as you know - we're home to Pacific Command in each of these - each of services' separate component commands.

Thanks very much.

[Operator Instructions] Our next question comes from the line of Joe Morford with RBC Capital Markets. Your line is now open. Please go ahead.

Thanks. Most of my follow-ups have been asked, but just a couple quick housekeeping things. You did book about $1.9 million of gains on sale of leased assets. Is that something we should expect on a more regular basis going forward, or is this more of a one-off?

It's a one off.

Okay. And then the real estate property sold, was that an OREO property relative to the recovery in Guam? Or was that --?

No. It was a residential property that we had in Guam, but it was not in OREO.

Okay. That's it, thanks so much.

There are no further questions. I would now like to hand the call back to Cindy Wyrick for closing comments.

I'd like to thank everyone for joining us today and for your continued interest in Bank of Hawaii. As always, if you have any additional questions or need further clarification on any of the topics we discussed today, please feel free to contact me. Have a great day everyone.

Ladies and gentleman, this does conclude today's program. And you may all disconnect. Everybody have a wonderful day.